Are income poverty and perceptions of financial difficulties dynamically interrelated?

- The relationship between income poverty and perceptions of financial difficulties is analysed.
- A feedback effect from past perceived financial difficulties on current income poverty is found.
- Perceptions can have an objective effect on individuals' outcomes.
- Data is from Luxembourg and results are robust to different specifications.

An individual's economic ill fare can be assessed both objectively, looking at one's income with reference to a poverty line, or subjectively, on the basis of the individual's perceived experience of financial difficulties. Although these are distinct perspectives, income poverty and perceptions of financial difficulties are likely to be interrelated. Low income (especially if it persists) is likely to negatively affect perceptions of financial difficulties and, as recently suggested by the behavioural economics literature, (past) subjective sentiment may in return influence individual's income generating ability and poverty status. The aim of this paper is to determine the extent of these dynamic cross-effects between both processes. Using Luxembourg survey data, our main result highlights the existence of a feedback effect from past perceived financial difficulties on current income poverty suggesting that subjective perceptions can have objective effects on an individual's behaviour and outcomes.